Journal of the Eastern Asia Society for Transportation Studies, Vol. 6, pp.

3899 - 3914, 2005

PRIVATE FINANCE FOR ROAD PROJECTS IN DEVELOPING

COUNTRIES: IMPROVING TRANSPARENCY THROUGH VFM RISK
ASSESSMENT
Diego Fernando TANAKA Haruo ISHIDA
Graduate Student Professor
Graduate School of Systems and Information Eng. Institute of Policy and Planning Sciences
University of Tsukuba University of Tsukuba
Tennodai 1-1-1, Tsukuba Tennodai 1-1-1, Tsukuba
Ibaraki 305-8573, Japan Ibaraki 305-8573, Japan
Telefax: +81-298-53-5591 Telefax: +81-298-53-5591
E-mail: dftanaka@sk.tsukuba.ac.jp E-mail: ishida@sk.tsukuba.ac.jp

Morito TSUTSUMI Naohisa OKAMOTO

Associate Professor Associate Professor
Institute of Policy and Planning Sciences Institute of Policy and Planning Sciences
University of Tsukuba University of Tsukuba
Tennodai 1-1-1, Tsukuba Tennodai 1-1-1, Tsukuba
Ibaraki 305-8573, Japan Ibaraki 305-8573, Japan
Telefax: +81-298-53-5591 Telefax: +81-298-53-5591
E-mail: tsutsumi@sk.tsukuba.ac.jp E-mail: okamoto@sk.tsukuba.ac.jp

Abstract: Private financing of road projects in developing countries has considerably

declined in recent years. Currency crisis have led several projects to fail and increase risk
levels of potential projects. For attracting private investments in risky projects, governments
have offered incentives and support measures. Government must assure themselves and
convince the general public that support measures given are not excessive. This could be
possible by using a transparent, open and quantitative method for evaluating/assessing the
risks. This paper reviews methods and techniques used for assessing the risk in private
finance projects. A value-for-money (VFM) methodology used in the UK is presented. It was
identified that the main shortcoming of the VFM method is surprisingly the lack of
transparency towards the general public. This paper indicates some considerations before
taking into account the application of the VFM method in developing countries, and proposes
a VFM risk assessment methodological approach for developing countries.

Key Words: VFM, Risk assessment, Road projects, Developing countries, Transparency

1. INTRODUCTION

Evaluation of projects in developing countries from the government’s funding point of view
has usually been done from an economic analysis perspective (Talvitie, 2000). However, in
the case of private sector financing of infrastructure projects it becomes necessary for
governments to assure that projects provide not only an important socio-economic value but
also that they are financially feasible. Road infrastructure projects are characterized by
requiring high investments in the initial years, and are generally exposed to many revenue
uncertainties which might reduce their financial viability (Lam and Tam, 1998). In order to
attract needed private investment in potentially risky or financially unviable projects,
governments have opted for offering the private sector incentives and support measures such
as grants, subsidies, tax-exemptions, revenue and foreign exchange guarantees, and sovereign
guarantees against force majeure and political risk, among others.

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In recent years, worsening economic conditions brought by the collapse of financial markets
in some developing countries have provoked the failure of several transport infrastructure
projects (especially toll roads) and drastically changed the private interest for them. As
mentioned by Estache and Strong (2000), the effects of financial crisis in Asia, Russia and
Brazil have resulted in dramatic increases in political and currency/exchange risk premiums.
Government incentives and support mechanisms have then become more indispensable now
than ever. But when giving these support mechanisms, governments have the responsibility of
assuring themselves as well as convincing the general public that the private sector is
rewarded accordingly to the risk taken and not done excessively. This task of assuring
transparency not only at the bidding and awarding process but also at later stages could be
achievable through an explicit and quantitative risk assessment method that is thought to be
lacking in many of the present projects. As indicated by Akintoye et al. (2001), the public
sector has generally preferred a qualitative approach for evaluating the risk. The reasons
given for not undertaking a full and detailed quantitative approach are: inexperience, lack of
knowledge, insufficiency of data, and difficulties in defining the risk in terms of likelihood
and impact. In cases where risks have been assessed using quantitative methods, the drawback
of these approaches has been related either to shortcomings of the techniques used, or to the
lack of openness to the public domain about the details of the risk assessment process due to
commercial confidentiality reasons.

Within this context, this paper aims at various issues. It firstly analyzes the present situation
of private finance road projects in developing countries, and then describes the main risk
factors and their allocation to the different parties in a road project. The paper then reviews
the commonly used methods for evaluating and assessing the risk, and identifies the
deficiencies and limitations of the existing techniques. Next, it presents a VFM methodology
used by the UK government for evaluating their private finance projects, and reveals the
shortcomings of this method. And finally, it suggests some considerations before taking into
account the application the UK method in developing countries, and proposes a
methodological approach for assessing the risk of private financing road projects that could
help the governments in developing countries showing the transparency of their decision
making.

2. PRIVATE FINANCING ROAD PROJECTS IN DEVELOPING COUNTRIES

2.1 Need of Private Financing by Government

The availability of an efficient transport system is essential to foster economic development

(Fujii, 1999). In developing countries, road transport is the dominant mode and represents the
biggest share in terms of freight and passenger traffic. Roads are important for their
contribution to economic growth by facilitating trade and increasing productivity in
agriculture/industrial activities, and also for improving living standards (Bhandari, 2002).
Developing nations should not only build road infrastructure projects but also operate and
maintain them successfully. However, as experience has shown, general absence of a
periodic/routine maintenance policy due to inadequate resource allocations has resulted in the
continuous deterioration of projects and the need of rehabilitation and reconstruction at much
higher costs (Quartey Jnr., 1996).

Road infrastructure in developing countries has been traditionally funded by governments

through a general budget allocation or by using dedicated taxes, access fees or tolls linked to

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road use (PIARC, 1999). However, fiscal stringencies and budgetary constraints faced by
many governments in the developing world have forced them to limit their spending on the
provision of new road projects and the maintenance and rehabilitation of existing facilities. In
order to keep pace with increasing population and rising demand for road infrastructure
projects, governments have advocated the private sector for fulfilling the required highways
needs. Project financing has emerged as a main financial instrument for bringing private
capitals into the provision of road projects. Project financing is not a new tool and has been
used for hundreds of years in the mineral resource sector, but it begin to spread widely in the
seventies with the development of an oil field project in the North Sea by the British
Petroleum-BP (De Lemos et al., 2000). Under this financing technique project lenders
primarily look at the cash flows and earnings of the project for the repayment of the debt
service. In contrast with corporate finance, project financing is done on a non-recourse or
limited recourse basis, where lenders have normally little or no financial recourse against the
project sponsor/promoter for the repayment of their loans.

2.2 Types of Private Financing Schemes

Several types of Public-Private Partnerships (PPP) structures have been introduced worldwide
and they differentiate upon the responsibilities and risk allocation between the public and the
private sectors. The PPP spectrum ranges from a simple commercialization of assets that
remains under public ownership on one side, right through a full privatization of facilities on
the other side, with several schemes in between that might involve jointly public-private
financing for the project.

In this study, private involvement in road infrastructure provision follows a classification

given by the World Bank (2004), which classifies contract structures in four types:

1) Concessions: Occurs when a private entity takes over the management of a state-owned
road for a given period during which it also assumes significant investment risk.
Concession schemes can be further classified in the following categories: a) Rehabilitate-
Operate-Transfer (ROT); b) Rehabilitate-Lease-Transfer (RLT) or Rehabilitate-Rent-
Transfer (RRT); and c) Build-Rehabilitate-Operate-Transfer (BROT)

2) Greenfield Projects: Take place when a private entity or a public-private joint venture
builds and operates a new road project for the period specified in the contract. The road
project usually returns to the public sector at the end of the concession period. Greenfield
projects can be further classified in the next categories: a) Build-Lease-Own (BLO); b)
Build-Operate-Transfer (BOT) or Build-Own-Operate-Transfer (BOOT); and c) Build-
Own-Operate (BOO)

3) Divestitures: Occurs when a private entity buys an equity stake in a state-owned toll road
company through an asset sale, public offering, or mass privatization program. Divestures
can be further classified into two categories: a) Full; and b) Partial.

4) Management and Lease Contracts: In this type of contracts a private entity takes over the
management of a state-owned road project for a given period. The road project is owned
by the public sector, and investment decisions and financial responsibilities also remain
with that sector.

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2.3 Recent Private Sector Participation in Toll Road Projects (1990-2003)

An analysis on the Private Participation in Infrastructure (PPI) project database (World Bank,
2004) for the period between 1990 and 2003 revealed that the private sector was involved in
359 toll road projects in the low- and middle-income developing countries. Figure 1 shows
the private investment by type of contract schemes for the given period.

Investment (US$ million)

0 1000 2000 3000 4000 5000 6000 7000 8000 9000 10000

1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003

Concession (expansion-rehabilitation) Divesture Greenfield (new) Management and lease

Source: Data for the analysis extracted from PPI Project Database - World Bank (2004)

Figure 1. Private Investment in Toll Road Projects by Type of Contract between 1990-2003

In 1990, private investment in toll road infrastructure was largely pulled by the Argentinean
and Mexican wide-ranging toll road programs. The following years were characterized by a
general decrease in investment commitments. Between 1996 and 1998, private investments
rose again and reached a peak in 1997 with about 10 billion dollars in 61 awarded contracts.
Financial crisis that affected many developing countries in the late nineties significantly
reduced the private interest for roads in the following years. In year 2003, investments by the
private sector in toll roads projects were just US$945 million (the lowest level since 1990).

2.4 Cancelled Toll Road Projects

For the period from 1990 to 2003, 31 out of the 359 toll road projects that involved private
participation in developing countries were cancelled and taken over by the government. From
the 31 failed projects, nineteen were greenfields, eleven were concessions, and the remaining
was a divesture project. The value of cancelled projects by region, type of contract, and its
country distribution is shown in Figure 2.

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7000
No. Failed
6000 Region Countries
Projects
China 8
5000 East Asia and the Indonesia 3
US$ (millions)

Pacific Thailand 1
4000 Lao PDR 1
Europe and Central
Hungary 1
Asia
3000 Latin America and the Argentina 1
Caribbean Mexico 16
2000 TOTAL 31

1000

0
East Asia and Pacific Europe and Central Asia Latin America and the Caribbean
Concession (expansion-rehabilitation) Divesture Greenfield (new)

Figure 2. Value of Cancelled Projects by Region, Type of Contract, and Country Distribution
during 1990-2003

In Mexico, main reasons for the failure of road concession projects were attributed to: lower
than expected revenues due to traffic shortfalls; excessively high toll rates; and the currency
crisis of 1994. In the East Asia region, the currency crisis of 1997 seems to be the most
influencing factor for the failure of toll road projects. Currency devaluation and rising interest
rates have seriously affected many projects in the whole region.

3. RISK CHARACTERISTICS OF PPP ROAD PROJECTS

3.1 Risk Management

Risk and uncertainty with potential damaging consequences are inherent in all projects
regardless of their nature. Due to the high degree of risk nature of construction business
activities, risk management has been used by the construction industry and its clients to
address and control the risks which they are, or might be, exposed to (Akintoye and
MacLeod, 1997). From a little more general perspective, risk management has been defined
as a structured approach to identify, assess and control the risks that emerge during the course
of the policy, program or project lifecycle (HM Treasury, 2003). Risk management is a
continuous and interactive cycle which could be comprised of the following three main
stages: risk identification, risk assessment, and risk response (Figure 3).

Risk Identification

Risk Assessment

Risk Response

Figure 3. Risk Management Interactive Process

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The purpose of the risk identification stage is to define as extensively as possible, a list with
all types and sources of risks and uncertainties that might have an impact on the project. It is a
crucial stage for the risk management process, because if a risk cannot be identified, it cannot
consequently be evaluated and managed. According to Merna and Njiru (2002), risk
identification techniques fall into three categories: intuitive, inductive (e.g. ‘What if?’
techniques) and deductive (e.g. ‘So how?’ techniques). Some of the most common methods
used for the identification of risk include: brainstorming, prompt lists, checklists, interviews
and risk registers.

The risk evaluation/assessment stage which is the main focus of this study is aimed at
determining the likely financial impact of all the risks that were identified in the previous
stage. Risks are generally assessed by using two types of approaches: qualitative methods or
quantitative methods. However, in many occasions the combination of both methods has been
suggested as the approach to be followed. The amount of effort committed for the assessment
of risk varies a lot, but the general rule has been to use as little as is necessary to arrive at
reliable planning decisions (Grey, 1995). A more detail description on the methods used for
risk assessment is covered in Section 4 of this paper.

The objective of the risk response stage is to reduce the potential impact of risks and also to
increase the control over them. Risk response has been often referred to as risk control, which
involves handling risks in a manner that achieves project and business goals efficiently and
effectively (Merna and Njiru, 2002). Risk response strategies have been generally classified
into four categories: risk reduction, risk avoidance/elimination, risk transfer and risk
retention/absorption (Akintoye et al. 2001). Alternative designs, contingency allowances,
contractual risk allocation arrangements, and insurance are among the preferred tools used for
risk response. If new risks arise as a result of introducing the risk response strategies, the risk
management process continues interactively passing again through the identification-
assessment-response stages.

3.2 PPP Road Projects Main Risks and their Allocation in Developing Countries

Several studies and research papers have documented the identification of risks in transport
infrastructure projects and related road schemes (Lam, 1999; Estache and Strong, 2000;
World Bank and Ministry of Construction of Japan-MOCJ, 1999; Asian Development Bank,
2000). Although risk factors differ from project to project, there are some common factors
that could affect projects in general. A list with of some of the most typical risks that could
appear in a PPP road project in a developing country is shown in Table 1.

Project risks should be assigned to the public or private entity that is best at controlling and
managing them. Figure 4 shows the allocation of risk between the government and the private
sector proposed or adopted for some PPP road schemes in selected developing countries. In
most of the cases, the private sector has taken on risk associated with the design, financing,
construction, operation and maintenance of facilities, general regulatory risks as well as cover
for insurable force majeure events. On the other hand, the public sector has been responsible
for environmental license approvals and other planning permits, right-of-way land
acquisition, discriminatory regulatory risk, and uninsurable force majeure events and political
risks.

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Table 1. Main Factors of Risks Encountered by PPP Road Projects

Risk Factor Cause

Land Acquisition, ROW Due to the possibility that: 1.Land costs are higher than expected; 2.
Acquisition of land is not timely carried out
Licenses approvals, permits, Due to the failure to obtain all necessary permits (e.g. environmental
consents licenses, building consents, etc.) for the execution of the project
Design Due to the possibility of the project design not achieving the required
output specifications
Construction/Rehabilitation Arising because of an increase in the estimated project costs; or a time
schedule delay for the construction/rehabilitation works
Operation & Maintenance Due to higher than anticipated operation or maintenance cost; or the
un-compliance with the contract specified performance measures
Traffic/Revenue When the actual revenue is lower that the expected one because of: 1.
Traffic shortfalls; 2. Impossibility to charge user at the projected rates
Financial Arising when the construction/rehabilitation cost or the project
financing cost increases due to higher that forecasted rates for: 1.
Interest rates; 2. Inflation; 3. Devaluation
Force Majeure Due to the possible occurrence of unexpected events non-controllable
by the parties. Risk of force majeure can be: 1. Insurable (e.g. against
natural disasters, employer/public liability, etc.); 2. Non-insurable
(war, terrorist acts, archeological discovers, expropriation, etc.)
Regulatory Because of changes in legislation or unsupportive government policies
that have a negative impact in the project. Regulatory risk can be of
two types: 1. Discriminatory (e.g. changes contractual toll rates); 2.
General (e.g. changes in tax rate policy)

Asian South
Risk Factor Hungary Colombia
Countries Africa
Land Acquisition, ROW □ □ △ □
Licenses approvals, permits, consents □ □ □ □
Design ○ ○ ○ ○
Construction/Rehabilitation ○ ○ △ ○
Operation & Maintenance ○ ○ ○ ○
Traffic/Revenue △ ○ ○ ○
Financial (Devaluation) □ ○ △ ○
Financial (Inflation) □ ○ ○ ○
Financial (Interest rates) ○ ○ ○ ○
Force Majeure (Insurable) ○ ○ ○ ○
Force Majeure (Political/Non-insurable) □ □ □ □
Regulatory (General) ○ ○ ○ ○
Regulatory (Toll rates) □ □ □ □

○ Private △ Shared □ Government

Sources: Asian Countries: Asian Development Bank (2000); Hungary: Szavo (1999); Colombia: Ministry of
Transport - National Institute of Concessions (2003); South Africa: National Treasury (2004)

Figure 4. Risk Allocation in PPP Road Projects in Selected Developing Countries.

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4. REVIEW OF RISK ASSESSMENT METHODS IN PPP PROJECTS

Evaluation of the financial viability of private financing projects requires the development of
an investment model in which financial indicators (e.g. payback, internal rate of return, net
present value) are used for measuring the value of the investment (The Institution of Civil
Engineers et al., 2002). In order for the financial model to be accurate and complete, it should
not only analyze the key parameters (like revenues, capital costs, operation costs, etc.) cash
flows but also assess the potential impact that risks could have on these individual
parameters.

4.1 Lack of Research on Risk Assessment from Government Viewpoint

Although several studies have analyzed the point of view of the private sector from a risk
evaluation/assessment perspective, the authors identified that there is very limited research
that document the way in which governments have evaluated and assess the risk of private
financing projects. Ranasinghe (1999) mentioned that quite a few quantitative approaches can
be used to analyze the financing and conduct risk analysis of BOT projects, and therefore his
study was aimed at proposing a model that could be used by governments for analyzing the
viability of private sector participation in infrastructure projects. Kumaraswamy and Zhang
(2001) have also pointed out that specific literature discussing governmental practices in
managing BOT projects is really scarce. The National Audit Office (NAO) in the UK have
examined the government experience in some of the privately financed road projects
(National Audit Office, 1998), but their report have been found to be lacking of detailed
information about the methodology and assumptions (such as likelihood of occurrence and
consequence impact cost) used for assessing the risk in the projects.

4.2 Risk Assessment Approaches

From a review on the existing methodologies used for the evaluation and assessment of risk in
the financial appraisal of projects, two main categories of approaches were identified:
qualitative techniques and quantitative techniques.

4.2.1 Qualitative Techniques

Qualitative techniques have been used for compiling a list of the main risk sources and
describing their likely consequences, without entering in details about the quantification of
their probability of occurrence. (Merna and Njiru, 2002). The next step after all sources of
risk are identified is to define some kind of order of priority. Due to the limited time and
resources generally available for this prioritization task, risk assessment may be biased
towards the use of relatively simple procedures such as qualitative and semi-quantitative
techniques (Ward, 1999).

Risk registers are one of the most common examples of qualitative approaches. A risk register
is usually a tabular form document or database which list all risk relevant to the project,
together with some information useful for the management of those risks (Simon et al., 1997).
According to Ward (1999), risk registers has the attraction of simplicity and convenience, but
also has a number of shortcomings including: 1.Unsufficient description of individual risks
drivers which might create ambiguity and misunderstanding; 2.Risk inter-dependencies are
ignored; and 3.Limited guidance on the relative importance of individual risk drivers.

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Semi-quantitative approaches have also been applied for ranking the risk by means of
probability-impact (P-I) tables. In such tables, probability and impact of risks are subjectively
assessed by using qualitative scaling factors (e.g. a five category scale might include: very
high, high, medium, low and very low). Following, a range of values/weights are assigned to
the qualitative scaling factors and P-I scores for each of the risks can then be derived by
multiplying the values of their probability and impact. Finally, the most important risks (e.g.
those with the highest P-I scores) are classified in order of severity (high, medium, low). Vose
(2000) mentioned that the key drawback to the semi-quantitative approach is the high
dependency of the process on the scale (e.g. linear, logarithmic) of values/weights that are
assigned for the qualitative scaling factors.

4.2.2 Quantitative Techniques

Quantitative techniques aim to represent the likelihood and impact of risks in terms of the
usual planning measures, such as time and money (Grey, 1995). Two of the most widely used
quantitative risk analysis techniques in the financial appraisal of projects are: deterministic
analysis techniques and probabilistic analysis techniques (Merna and Njiru, 2002).

Deterministic Techniques

Sensitivity analysis is probably the most representative approach among the deterministic
techniques. Sensitivity analysis examines the effect of changes in the value of the model’s
dependent variable resulting from the changes in the value of one or more of the input
variables to the model. The most popular form of sensitivity analysis is the one-factor-at-the-
time approach, wherein the main advantage is that it allows interpretation of the results in an
easily understandable way. Another form of sensitivity analysis is the “scenario analysis”,
which recalculates the model for a combination of simultaneous changes in the input variables
(Van Groenendaal and Kleijnen, 1997). Frequently, three types of scenarios are distinguished:
an optimistic case, a base case, and a pessimistic case. Some of the major shortcomings of
using sensitivity analysis are: 1. Equal probability of occurrence is given to all scenarios
(despite the likelihood of getting some scenarios with extreme values is lower); 2. Possible
inter-dependencies between the variables are ignored; 3. In big projects with many
items/activities, a combination of all variables can create a too large set of scenarios.

Probabilistic Techniques

There are two major probabilistic approaches to quantitative risk assessment: analytical
approaches and simulation approaches. Analytical approaches require for each of the
uncertain variables in a model to be associated with a probability distribution function (PDF)
that mathematically describes its shape. Then, the PDF’s of variables are mathematically
combined to derive another PDF that describes the exact model distribution outcome. If the
risk model would be described by the sum of two simple and independent distributions, then
the analytical approach may be considered as a suitable option. However, risk models of real
life projects are generally much complex and usually formed by several distributions that do
not allow such simple mathematical manipulation, which makes this approach not practical
for implementation (Vose, 2000).

Probabilistic simulation approaches overcome the main deficiencies of deterministic methods

by assigning each of the uncertain variables with a PDF rather than single-value estimate. The

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objective of a Monte Carlo simulation is to calculate the combined impact in the variability of
the model’s input parameters to determine a probability distribution of the possible model
outcomes. The simulation technique involves a random sampling of values for each
probability distribution within the model to produce hundreds or even thousands of scenarios
(also called iterations or trials) which are used to create the probability distribution of the
model outcome (Simon et al., 1997; Vose, 2000).

5. THE UK VALUE FOR MONEY (VFM) APPROACH

Public finance constraints for maintaining and providing transport infrastructure have resulted
in successive UK governments seeking to encourage the private sector participation in the
development of road projects. Three potential types of projects (financially-free standing,
joint ventures, and service sold) were identified to be implemented under the Private Finance
Initiative (PFI) in the UK. Out of the three, the Design, Build, Financing and Operate (DBFO)
scheme has been the preferred strategy for road financing. Just in England alone during the
last decade, the Highways Agency have secured the private sector participation in ten DBFO
road projects, from which eight have at present an operational status and the remaining two
are still under construction.

5.1 Basis of the VFM Approach

The two fundamental requirements that every PFI projects must fulfill are: 1. Appropriate
transfer of risk to the private sector; and 2. Achievement of VFM by the taxpayers. It is
important to bear in mind that an optimum, rather than a maximum risk transfer is the
objective of the PFI (Treasury Taskforce, 1999). Allocation of project risk to the private sector
should only be sought if they are in a position to best control and manage the risks, or
otherwise will result in a deterioration of VFM. But, what is VFM? According to Grout
(1997), VFM for the public sector can be defined as realizing the lowest out-turn cost over the
whole life of the contract. In order to demonstrate VFM, it is first necessary to develop a
Public Sector Comparator (PSC) which is generally based on a similar historic publicly
funded project that would serve as a benchmark for the PFI bid. The PSC must be expressed
in present value amounts and should include the full cost of providing the required output as
well as fully accounting for the risk that would be encountered by that style of procurement
(Treasury Taskforce, 1998). A VFM conceptual framework for a PFI project is shown in
Figure 5.

PSC Project base cost Retained risk cost Transferred risk cost
(Whole-life appraisal) (by Government) (from Government to Private)

VFM = PSC - PFI Bid

PFI Service payment cost Retained risk cost

Bid （Include risk transferred by Government) (by Government)

Figure 5. VFM Conceptual Framework in a PFI Project.

Considering the importance that risk allocation have in a concession project, the DBFO
approach to highway projects in the UK as implemented under the PFI, may present the best

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practice in the treatment of these risks (World Bank and MOCJ, 1999). The Highways Agency
(1997) reported that VFM has been delivered in the first eight DBFO road contracts in
England with average cost savings of about 15%. These VFM savings were obtained by
comparing the net present value of the PSC with the net present value of the projected
payment under the DBFO contract.

5.2 Shortcomings of the Current UK VFM Approach

Despite of the relatively successful experience of the UK government in introducing the PFI
(with better results in roads and prison projects than in other sectors), the authors have
identified some deficiencies and shortcomings in relation with the VFM approach that are
worth to mention.

First of all, although the great importance that risk transfer has on evaluating the VFM, the
guidance given by the central government on the construction of the PSC and the
methodology for assessing the risk has been in many cases neither clear and transparent nor
detailed enough. Illustrations on the working of the PSC methodology has been generalized
too much because of preserving confidentiality, and just some pointers, instructions and clues
had been given, rather than actual details on the procurement (Treasury Taskforce, 1999).
Pollock (2002) have claimed that the whole methodology underpinning calculation of risks it
is not clear at all, even though the whole of government policy is hanging on these claims of
risk transfer that presumably give good VFM.

Following, a study by Akintoye et al. (2001) about the methodology used by governments for
evaluating the risk in PFI projects identified that in the few cases where a full quantitative
approach took place, the deterministic techniques were predominantly used. The Treasury
Taskforce (1999) have also recognized that despite more sophisticated techniques (e.g.
probabilistic simulation) could be employed as an alternative to the deterministic approach, it
is recommended not to used them in every project due to the high cost usually required. A
review on the limited publicly available information about risk analysis in PFI projects
revealed that in the case of DBFO road projects, some risk simulation analysis was
undertaken but solely for the construction cost variable. It seems that other important
uncertain variables were not included in the risk analysis which put at stake the credibility of
the obtained results.

At last but perhaps the most important issue is that the veracity of the cost savings brought by
the VFM approach has been under growing skepticism by the general public due to the
government refusal to disclose information on the valuation place on the risks, and on the
fundaments of the risk assessment methodology because of confidentiality reasons. The
model contract and other tender documentation have included confidentiality clauses intended
to preserve confidentiality for the duration of the road contracts (National Audit Office,
1998). The Wales Watch (2001) noted that any attempt to gain some insight as to whether the
taxpayers have got a good deal always hits the brick wall of commercial confidentiality and
therefore it is very difficult to see how any assessment can be made on the VFM if
information related to the valuation of risk and discounting is kept secret. The details of risk
assessment which underpins the VFM calculations should be available for the public in
general and not exclusively to a few selected public bodies, that according to Heald (2003)
are the only ones that can have access to PFI documentation on the conditions necessary for a
comprehensive analysis on the VFM.

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6. TOWARDS A MORE TRANSPARENT VFM RISK ASSESSMENT FOR

DEVELOPING COUNTRIES

The VFM approach is expected to bring, among other benefits, transparency about the
government decision making process. However as this paper shows, despite of the better way
for accounting the risks in PFI/PPP projects that the VFM methodology could bring, the
approach taken by the UK government is lacking of transparency with the general public due
to the decision of not revealing details about the risk assessment process undertaken in the
projects and which makes part of the contractual documents. One of the reasons for the
government and the private sector to agree in preserving confidentiality in their contracts is
the possible advantages that other competitor parties could take from this experience in future
governmental bidding projects. But by keeping contract information in secret, the presumable
good VFM results claimed by the government were consequently at doubt, and some
transparency organizations have argued that the public sector’s reason for not releasing
contract information is to avoid a possible public embarrassment (Wales Watch, 2001).

The “negotiation based” type of contract procurement used in the UK is probably at the core
of the transparency problem. Allowing for negotiations at the bidding and awarding stages
might let the private sector to propose innovative arrangement for designs, risk sharing, toll
pricing and other elements of the bidding process (Fisher and Babbar, 1996). Its main
deficiencies are the high public/private resources (time, effort, and cost) required, the
complexity of evaluating alternative proposals, and the lack of a full transparent process
(usually the details of the negotiations are not open to the public domain even years after the
contracts had been signed). Other types of bidding procurement in which terms of contracts
are clearly predefined, equal for all participants and where as little as possible is left for future
negotiations (such as those used in Colombia, Chile and Argentina) are considered to be more
competitive and transparent (World Bank and Ministry of Construction of Japan, 1999).

6.1 Considerations Before Applying the VFM Approach in Developing Countries

Before considering the applicability of the VFM risk assessment approach in developing
countries it is first necessary to understand the major differences that the approach will face in
the context of developing countries given the sometimes contrasting environment
(economic/social/political) in which it was originally implemented in the UK. Some of these
differences are:

Contract type: The DBFO road procurement scheme as implemented under the PFI in the UK
has not been tried in developing countries (Silva, 2000). Data analysis on the PPI project
database (World Bank, 2004), demonstrate that the majority of private financing in road
projects undertaken by developing countries has been of the concession type (for expansion
or rehabilitation schemes), or of the greenfield type (for completely new schemes).

Payment mechanism: The shadow tolling mechanism (where payment to the concessionaires
is not made by the direct road users but by the government itself through public taxes) used in
the UK DBFO/PFI road schemes is probably not very attractive to governments of developing
countries because it does not help to solve their budgetary limitation problem and privately
financed projects would have anyway to be annually repaid by using public sector scarce
funds. Instead, it is more appealing for them to newly implement or continue using the real
tolling mechanism (where users are directly charged at tollbooths - users pay principle).

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Procurement process: Being aware of the transparency shortcomings of the negotiation based
type of procuring contracts used in the UK, it is recommended that developing countries
implement simple, transparent and competitive biding procedures. For fighting corruption and
giving more transparency to the procurement process, recent steps taken by the government of
Colombia are worth to mention (El Tiempo, 2002): 1. Creation of anticorruption watching
bodies; 2. Awarding of contracts only at public hearings; 3. All bidding documentation (e.g.
terms of reference of contracts, specifications) must be open and available to the general
public view previous to the contract award.

Concession length: DBFO road contracts in the UK were bidded for fixed term concession
periods (average of 30 years). In developing countries the concession period have varied from
fixed terms in the early contracts to variable terms in lately concession agreements. The
Least-Present-Value-of-Revenues (LPVR) approach suggested by Engel et al. (1998) is
considered of best practice in dealing with variable term concessions in PPP road projects.
The LPVR method is also helpful in reducing the traffic/revenue risk by allowing contracts to
be lengthened whenever demand is lower than expected, or shortened when demand is higher
than expected.

It seems from above that some developing countries have created effective mechanisms for
procuring PPP projects, and this bring the question of why governments of those countries
should consider applying the VFM approach? The main reason governments may have for
considering applying the VFM approach is to not relying only on competition for achieving
the best deal at the bidding process. Normally the winning bidder is the one that proposes the
lowest cost for a predefined bidding criteria (e.g. LPVR, toll charges, etc.), even if this cost is
greatly exceeding the estimate value that the government have anticipated for the project.
While competition between the bidders might bring some tension into the tender stage, it
cannot provide the compelling evidence that the government is getting the best value for the
price it is paying (particularly when some incentives and support measures are given). The
advantage of estimating a PSC adjusted for risk transferred could serve not only to provide a
comparison benchmark for the proponent bids, but also to demonstrate that the risk
transferred to the private sector are rewarded accordingly to the risk taken and not
excessively. However, as previously mentioned, in order to achieve transparency using the
VFM approach, it is necessary for the whole analysis and its risk quantification assumptions
to be open to the general public and not just to the government authorities.

6.2 VFM Risk Assessment Methodological Approach for Developing Countries

The VFM risk assessment proposed approach is based on a probabilistic Monte Carlo
simulation model that aims at determining the probability distribution of the model outcomes
(PSC, PFI bid revenue from toll collection) from which it would be possible to assess the
VFM of the road project in a developing country. The proposed approach assumes that main
risks which affect the project have been obtained at a preliminary risk identification stage, and
also that needed risk response measures are already in place. The process for estimating the
VFM in the proposed approach can be comprised of the following four main steps:

1) The first step is to set up the structure of the financial model in which a VFM risk
assessment can be performed. For this purpose, the use of spreadsheets is advisable due to
their enormous flexibility for representing the cost and revenue structures in a model.
Moreover, spreadsheets allow direct interactions with several specialized risk analysis
software packages in which risk modeling can be run.

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2) The second step assigns a PDF for each of the uncertain variables in the spreadsheet
model. In determining the PDF that best represent the variables, two different approaches
are usually used: A) If there is available data on the variable, several techniques exist for
fitting this data to empirical (non-parametric) or mathematical (parametric) distributions;
and B) If data on the variable is not available, the parameters that define the distribution
can be found through expert opinion (Vose, 2000).

3) The third step is to account for any correlation effect between the uncertain variables that
will lead to build realistic models. The quantification of the correlation effect between the
variables can be found in two alternative ways: A) If data is available, then it can be used
for modeling the correlation between the uncertain variables; and B) If data is not
available, correlations coefficients must be estimated from the subjective opinion of
experts (Vose, 2000).

4) The fourth step consists of running the Monte Carlo simulation model and estimating the
probability distribution of the outcome variable (PSC/PFI bid revenue from tolls). For the
model to be correct, the effect of correlation between variables must be included.

In the process of building a VFM risk assessment model by governments of developing

countries, several difficulties are likely to appear. First of all, the kind of data required for
undertaking a formal assessment of risk in projects may be not available in most these
countries. Therefore, input data for the risk model such as the PDF’s and correlations must be
obtained from the subjective assessment of experts or specialists. Following, governments of
developing countries might also suffer from the in-house scarcity of skilled and experienced
manpower for conducting proper risk assessment/management in their PPP projects, which
forced them to rely on external consultants. Finally, carrying out probabilistic simulation
approaches usually involve high costs which may act as a deterrent factor against the use of
sophisticated risk assessment techniques.

7. CONCLUSIONS

Our review on the methodologies for assessing risk in projects shows that qualitative
techniques are mostly preferred by governments due to their simplicity of use. In cases where
quantitative analysis is needed, the tendency for governments has been to rely on external
consultants. Probabilistic simulation techniques overcome the deficiencies of other
approaches, but using these techniques is generally more complex and costly.

This study reveals that the VFM approach introduced by the UK government lacks
transparency in dealing with general public. The government in the UK has refused to
disclose information on the risk assessment methodology and the valuation of risk included in
the contractual documents, due to commercial confidentiality reasons. However, by keeping
contract information in secret, the presumably good VFM savings claimed by the government
has been under growing skepticism by the general public. It was found that the transparency
shortcomings of the negotiation based type contract procurement employed in the UK, can be
overcome by using simpler, clearer competitive bidding procedures in which contract terms
are specified in advance and the contracting parties barely rely on backdoor negotiations.

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The study also identified that despite the effective procurement methods that some developing
countries employ, the main reason for considering the application of the VFM method is not
to rely solely on competition for getting the best deal at the bidding stage. While competition
for a bidding criteria allows the government to choose the lowest cost proposal among
bidders, it does not guarantee that this cost will not exceed the value the government have
estimated for the project. The construction of a PSC can provide not only a benchmark for the
private bid but also assures governments and the general public that the transferred risks are
rewarded according to the risks taken. In order for the government to achieve transparency in
their decision making, the proposed VFM risk assessment approach should be opened to the
general public and not just for the public authorities.

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